For the first time since Russian goldminer listings began on the London Stock Exchange more than a decade ago, Russian shareholders have taken a major Russian goldminer to the UK regulator, alleging asset stripping and share value dilution, along with the charge that no justice is possible in the Russian courts. At the heart of the complaint filing is the sale of shares at what is alleged to have been ten times less than their fair value, and the valuation of gold reserves transferred at many muliples below book. The gold in question includes part of the most celebrated vein of unmined gold in Russia – the fabled Sukhoi Log deposit, in the southeastern Siberian region of Irkutsk.

A Moscow-based holding, Westway Alliance Corporation, with an 8% shareholding in the Irkutsk region goldminer Lenzoloto (“Lena [River] Gold”), filed its claim with the Financial Services Authority (FSA) on January 29.

The corporate targets identified in the complaint are the AIM-listed Polyus Gold (PLZL:RU, PLZL:LI), its management, and controlling shareholder, Mikhail Prokhorov. The FSA told Westway in March that an investigation has commenced. However, the FSA declines to respond publicly to questions about the case. The agency also warns complainants that its charter allows it to dispose of a complaint without informing anyone, unless the outcome is a disciplinary action posted on the FSA’s website. In 2007, the FSA says it issued just one disciplinary order or enforcement notice; in 2008, there were 8; and in 2009 so far, 2.

Westway told Minesite that between 2003 and 2006, Polyus took over the gold-producing and exploration assets of Lenzoloto at one price; then devalued them for transfer to Polyus; raised their value to achieve a significantly greater capital value for Polyus; and thereby deprived Westway as a minority shareholder in Lenzoloto of the substantial difference in value. Calculated on the basis of under-valued or reserves allegedly lost to Lenzoloto, Westway’s claim targets an amount estimated at $526 million; of that, its 8% stake should represent a claim to about $42 million.

In 2007, when Westway filed its initial claim in the Irkutsk regional arbitration court, the case was dismissed on a technicality. This was that, at the time of filing, and in the court papers, Westway failed to provide proof that it was the owner of Lenzoloto shares, although at the time the record of title indicated a nominee shareholder.
Westway’s Russian lawyers also warned that Prokhorov, one of Russia’s wealthiest individuals – he currently controls Renaissance Capital investment bank, and 18% of United Company Rusal, the bauxite and aluminium monopoly — was such a powerful figure in Russia, it was unlikely that Westway’s claim could receive a fair hearing in the Russian courts.

The UK High Court recently upheld this view, when Justice Christopher Clarke ruled that one of the original, founding shareholders of Rusal, Michael Cherney (Mikhail Chernoy), could not receive a fair hearing in the Russian courts against Rusal’s controlling shareholder, and his one-time protégé, Oleg Deripaska. Clarke said in his July 3, 2008, judgement, ordering Deripaska to trial on Cherney’s suit in the High Court: “It is…apparent to me that, if this claim is not allowed to proceed in England, it will not proceed in Russia…in this particular case, there is a significant risk that Mr Cherney will not obtain in Russia a trial unaffected by improper interference by State actors and that substantial justice may not be done.”

For the time being, Westway has taken the less costly step of applying to the UK market regulator to rule on the conduct of Polyus’s management and shareholders towards minorities. Apart from a French investigation of an alleged sex offence in January 2007, from which Prokhorov was released without charges, he has not been the target of court or regulatory proceedings in Europe before.

In summary of Westway’s 11-page filing with the FSA, setting out five counts of alleged value stripping, the complaint declares: “ Restructuring processes like those described in Clauses 3.1 – 3.4 occur throughout the world. Nevertheless, interests of the minority shareholders must be ensured by either buyback or exchange of the shares for the shares in the profit-center company. In this case, the profit center is Polyus Gold OJSC. In neither of the above corporate actions the minority shareholders were offered either a buy-back arrangement of exchange of their shares for the shares in Polyus Gold OJSC.

“All of the above actions by the Polyus Group are economically [unprofitable] for Lenzoloto OJSC and exclusively target [the] stripping [of] Lenzoloto OJSC [Open Joint Stock Company] of its assets at the lowest possible price. In this regard various corporate schemes are applied in which the minority shareholders do not only lose their ability to participate in decision-making but also suffer tremendous damages. In the meantime, the shares in Polyus Gold itself are offered to investors on the London Stock Exchange, and the investors cannot even start to suspect the true origin of the assets, which Polyus Gold OJSC is comprised of.”

The facts in the FSA case begin in 2003, when Lenzoloto, a partially privatized placer-mining incorporation from the Soviet era, was sold to Norilsk Nickel. Subsequently in 2006, when Norilsk Nickel spun off and separately listed its gold assets, Lenzoloto and its subsidiary and affiliated companies became part of Polyus Gold. Before the takeover began, Lenzoloto was the leading placer producer in Russia, with annual output of around 300,000 ounces, and reserves estimated at 6.4 million oz, not counting Sukhoi Log. That deposit, with 33 million oz in reserves estimated at the time, had been part of Lenzoloto’s asset base in the 1990s. But this was stripped out of the enterprise by government fiat and court rulings in 1997, thereby ousting an Australian-South African partnership, with Standard Bank, from the Sukhoi Log mine plan.

The Sukhoi Log mining licence was revoked at the time, and the Kremlin has delayed reissuing it. But in 2003, when Prokhorov sought to buy Lenzoloto, it was recognized in the Russian market that whoever controlled Lenzoloto stood a good chance of taking the Sukhoi Log licence. Consequently, it was reported that the competition at a state auction of Lenzoloto’s shares on September 17, 2003, was fierce. Deripaska and two other major bidders drove up the price, obliging Norilsk Nickel to bid $152 million for the 45% stake. Counting earlier share purchases, Norilsk Nickel then held a control stake of 76%.

It didn’t take too long for Norilsk Nickel to acknowledge, if quietly, that it had over-paid. According to accounts and auditors’ notes issued by Polyus for 2004, the Norilsk Nickel group “reviewed the carrying value of goodwill arising on the acquisition of OJSC Lenzoloto”, and wrote off a total of $114.6 million. At the time, Maxim Finsky, the asset buyer for Prokhorov, justified his price by claiming that control of Lenzoloto improved the Norilsk Nickel group’s chances to win the Sukhoi Log tender. Russian press reports from the time indicate he calculated that in the ultimate bidding for Sukhoi Log, the Lenzoloto assets were worth to Norilsk Nickel about $300 million.

Westway now charges that once Norilsk Nickel, then Polyus had control of Lenzoto, they got the Lenzoloto board to agree to sell a 26% stake of the Pervenets deposit, one of the satellite gold deposits around Sukhoi Log, for the equivalent of $346. Westway has told FSA the fair price derived from an earlier transaction with Pervenets should have been $9.1 million.

The second count alleged against Polyus in the FSA claim sheet is that Lenzoloto subsidiaries were sold for $26 million, which was at the time “clearly lower than the market prices.” The third count alleges that a complex restructuring of Lenzoloto into a new company of similar name at a loss to the original company of $28.5 million in profit. The fourth count charges that between 2003 and the end of 2006, about 3.9 million oz in gold reserves, originally ascribed to Lenzoloto, “were ultimately transferred to the 100%-controlled subsidiary companies of the Polyus Group that fraudulently increased its capitalization on the London Stock Exchange.” Applying an April 2008 price for the reserves, the complaint charges that the reserve transfer between Lenzoloto and Polyus was $552.7 million. “Lenzoloto OJSC received for the assets with the market value of USD 552,665,991 USD 25,996,211 in total, which is more than 20 times less than their market value,” according to the text of the complaint.

Prokhorov’s Moscow holding is known as Onexim, and is headed by former Norilsk Nickel executive, Dmitry Razumov. The two were asked to respond to the charges in the FSA complaint by Westway. Their spokesman Igor Petrov took the questions, and has not responded.

The current chief executive of Polyus Gold, Evgeny Ivanov, and his deputy for corporate development, German Pikhoya, were asked to say whether they have received a letter from the FSA confirming the complaint, and setting out a questionnaire for their response. They were also asked to respond to Westway’s charges. Spokesman Anton Arens said that, to his knowledge, Polyus is unaware of claims by minority shareholders of Lenzoloto to Polyus Gold, and also unaware of any FSA investigation. Arens added that, to date, he does not know of any contact the FSA has made on the matter with Polyus Gold. He said he would ask Ivanov and Pikhoya, but they have not responded.

In a separate development, the federal mine licensing agency Rosnedra has revealed that it will not be putting the Sukhoi Log licence up for auction for at least another year. The deposit has been re-analyzed, and is now estimated to contain 60 million oz, double the volume believed a decade ago. Costs for building the mine have also doubled, and are now projected at almost $2 billion.